WASHINGTON - Escalating budgetary pressures from increased demand for social services, retiree benefits, and infrastructure, paired with volatile municipal market conditions and major revenue shortfalls, have states facing serious financial pressures and a negative outlook for the next 12 to 18 months, Moody's Investors Service said yesterday.
However, despite the continued recession and bleak outlook, Moody's does not expect "wholesale" rating downgrades of states, the rating agency said in a report released yesterday.
In addition, if enacted and well utilized, the economic stimulus package should also help states mitigate negative rating action, Moody's said.
The rating agency said its outlook for the states remains negative because of "the states' deteriorating financial positions as well as the reduced likelihood of being able to borrow their way out of a cash-flow shortfall or deficit position."
Its negative outlook on the state sector has been in place since February 2008. Since then, the economy has continued to deteriorate and states are grappling with a combined fiscal 2009 and 2010 budget gap of about $100 billion. Several states are reporting budget gaps for fiscal 2010 equal to 20% to 25% of their operating revenues, the report said.
Six states, Florida, Kentucky, Nevada, Ohio, Rhode Island, and Wisconsin, already carry negative outlooks from the rating agency, and California is on watch for a possible downgrade.
Moody's said it will use six factors - revenue declines, liquidity position, recession-induced spending pressures, deficit financing, federal stimulus, and management - for assessing the ratings on states in 2009.
The severity of the current recession is causing declining revenues that have bled states budgets, the report said.
Sales tax, corporate business tax, and personal income tax collections, which represent the largest sources of state revenues, have been hit extremely hard, it said.
"In some states, these revenue shortfalls have also begun to have an effect on liquidity, forcing states to rely on borrowing from various funds and issuing cash-flow notes for operations," Moody's said.
But as access to the capital markets has weakened, it could throw a wrench in states' plans to borrow their way out of trouble, the rating agency warned.
Prior to this downturn, state governments were able to depend on borrowing to resolve any cash-flow pressure or deficit. But access to the market has become constrained and governments can no longer assume that option will be available, according to Moody's.
Without market access, negative credit effects are likely to be more acute for governments such as California, Illinois, Michigan, New Jersey, Texas, and Wisconsin, which rely on annual short-term borrowing.
In addition, liquidity is especially important in the current market because unexpected cash drains could arise from a sudden increase in interest rates on variable-rate debt, the report said.
Demand for social services will continue to grow along with unemployment numbers in 2009, despite most states' efforts to rein in spending. As the economy worsens, more people will join the ranks of the unemployed and will apply for various social services increase.
The funded ratio of state pension funds is expected to decline after a 35% drop in the stock market, which is where most state pension funds are invested, according to Moody's.
These pressures are coming at the inconvenient time when most states are grappling with aging infrastructures from roads to schools, the rating agency said.
"Some states are choosing to hold off on additional commitments while others are concerned about contributing to additional unemployment and the risks inherent in unsafe infrastructure, therefore continuing to spend on these programs," the report said. Several states have proposed using bonds to finance infrastructure needs, while others are simply waiting on federal stimulus dollars.
Moody's said that even with multiple pressures weighing on states, they still have the power to tax and therefore this recession should not affect a state's ability to pay debt service.
"States possess significant powers to increase revenues, reduce expenditures, and push financial obligations to local governments, and most states are required to pay debt service before other expenditures," Moody's said. "As such, it is extremely unlikely that a state would default on its debt obligations."
